Chapter 8 Influences on Real Estate Values

Chapter 8: Objectives After completing this chapter, students will be able to: Identify the differences between the four broad forces and how these forces and perceptions affect the value of real estate

Key Terms Asbestos Clean Air Act Clean Water Act Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) Electromagnetic Fields (EMFs) Environmental Hazard Environmental Protection Agency (EPA) Asbestos A fibrous material derived from a naturally occurring group of minerals that is now considered hazardous. Clean Air Act Federal act that requires the EPA to develop air quality standards for existing pollutants along with establishing air standards for new sources of pollution. Clean Water Act Federal act which created a regulatory structure for the discharge of pollution into waterways and gave the EPA the right to enact control programs. Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) Federal act that addresses what to do with closed or abandoned waste sites. Also known as the Superfund. Electromagnetic Fields (EMFs) Invisible fields produced by electrically charged objects. Environmental Hazard A situation that exists in which there is potential for harm to persons or property from conditions that exist in a property or the surrounding area. Environmental Protection Agency (EPA) Federal agency tasked with creating and enforcing environmental protection standards and helping others with environmental pollution problems.

Key Terms cont. External Environmental Hazards External Obsolescence Internal Environmental Hazards Lead-Based Paint Hazard Reduction Act (Title X) Linkages Methamphetamine Mold National Environmental Policy Act (NEPA) Nuisance Radon External Environmental Hazards Environmental concerns that exist outside the boundaries of a property, which can have a significant impact on its value. External Obsolescence When something outside the control of a property makes it less desirable. External obsolescence can be locational or economic. Internal Environmental Hazards Environmental concerns that exist within property, which can have a significant impact on its value. Lead-Based Paint Hazard Reduction Act (Title X) Federal Act which requires sellers and landlords to disclose known lead paint hazards for homes built before 1978. Linkages The proximity of property to common destinations and conveniences, and the time required to reach those places. Methamphetamine An illegal, man-made drug that is extremely addictive. Mold Organic spores that grow where moisture is present. National Environmental Policy Act (NEPA) Federal act established in 1970 to, among other things, encourage productive and enjoyable harmony between man and his environment. Nuisance Anything emitting from outside the property boundaries that interferes with the owner’s right of quiet enjoyment. Radon A naturally occurring radioactive gas that emanates from the earth; it is odorless, colorless, and tasteless but has been identified as a cancer-causing agent.

Key Terms cont. Resource Conservation and Recovery Act (RCRA) Stigmatized Property Underground Storage Tanks (USTs) Urea-Formaldehyde Urea-Formaldehyde Foam Insulation (UFFI) Wetlands Resource Conservation and Recovery Act (RCRA) Safe Drinking Water Act (SDWA) Sick Building Syndrome Resource Conservation and Recovery Act (RCRA) Federal act that gives the EPA the authority to control hazardous waste throughout its entire life cycle, including its generation, transportation, treatment, storage, and disposal. Safe Drinking Water Act (SDWA) Federal act that established standards for water intended for human consumption. Sick Building Syndrome A condition of a structure where people suffer from headaches, fatigue, nausea, sore throat, nose and eye irritation, and other symptoms present only while in a building with poor air quality. Stigmatized Property A property made undesirable to most people by a past event, often a crime or environmental hazard. Underground Storage Tanks (USTs) Designated holding provisions that store a variety of substances such as heating oil, gasoline, chemicals, and hazardous waste. Urea-Formaldehyde A clear chemical used in manufacturing that is regulated by the EPA. Urea-Formaldehyde Foam Insulation (UFFI) A type of insulation popular at one point because it could be blown into an existing structure. It is now banned for home use by the EPA due to potential health risks from its toxic fumes. Wetlands Ecosystems where the land is permeated with water and are commonly referred to as swamps, bogs, and marshes.

Four Forces Influencing Real Estate Values PEGS: Physical forces Economic forces Governmental forces Social forces

Physical Forces May also be referred to as environmental and geographic forces May include conditions: On a property (specific) External to the property (broad)

(Physical) Environmental Forces Many are controlled at the federal level through federal laws and regulations Other environmental issues are controlled at the state or local level Certain inspections and/or disclosures may be required

Environmental Protection at the Federal Level National Environmental Policy Act (NEPA) Environmental Protection Agency (EPA) Clean Air Act (CAA) Clean Water Act (CWA) Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) Superfund Amendments and Reauthorization Act (SARA) Resource Conservation and Recovery Act (RCRA) Safe Drinking Water Act (SDWA) In 1970, the National Environmental Policy Act (NEPA) was enacted to: Declare a national policy which will encourage productive and enjoyable harmony between man and his environment; to promote efforts which will prevent or eliminate damage to the environment and biosphere and stimulate the health and welfare of man; enrich the understanding of the ecological systems and natural resources important to the Nation; and establish a Council on Environmental Quality. The EPA is tasked with creating and enforcing environmental protection standards, helping others with environmental pollution problems through the use of grants and other means, assisting the Council on Environmental Quality (CEQ) by suggesting policies and procedures for environmental protection, and providing research on environmental issues (such as the effect of pollution on the earth and methods for controlling pollution).

Environmental Protection—Wetlands Ecosystems where the land is permeated with water, and are commonly referred to as swamps, bogs, and marshes Protected under the federal Clean Water Act Enforced by the U.S. Army Corps of Engineers Some activities are prohibited and require a permit if they could permanently change or destroy the wetland habitat

Environmental Protection—Property Hazards Internal and external hazards Nuisance: Anything emitting from the outside of the property that interferes with the owner’s right of quiet enjoyment If a nuisance is permanent, it is an external obsolescence Environmental hazard: A situation that exists with potential for harm to persons or property from conditions that exist outside or within a property External environmental hazards are those concerns that exist outside the boundaries of a property, which can have a significant impact on its value. Proximity to nuclear power plans, presence of high-tension power lines Internal environmental hazards or hazards within a property can be as dangerous, or more dangerous, than external hazards. Asbestos, mold, radon

Common Environmental Hazards Asbestos Electromagnetic fields (EMFs) Lead Methamphetamine Poor air quality (sick building syndrome) Underground storage tanks (USTs) Urea-formaldehyde Mold Radon

(Physical) Geographic Forces Characteristics related to the environment surrounding the property that either can contribute or detract from value Topography Soil conditions Water Location and view (linkages) Climate Natural features and barriers

Work Problem What are some uses or locations where various types of natural features and barriers can either be a benefit or a hindrance to property value? Possible examples include (but are not limited to): • Ski slopes • Mountain resorts • Waterfront businesses and housing sites • Nature preservations and resorts

Economic Forces World events Energy costs War Terrorist activities Cost and availability of credit Employment levels Availability of employment Earnings levels Taxes Inflation

Government Forces Government services Revenue generating law (right of taxation) Right to regulate laws (police power) Governmental fiscal and monetary policies Secondary mortgage markets and government mortgage programs

Social Forces Demographic changes Migrations of the population Social trends Buyers tastes and standards

Stigmatized Properties Properties held to be undesirable by most people because of a past event or condition Crime, murder, suicide, drug activity, past environmental hazards (methamphetamine, fire, chemical spill) Determining value influence can be time intensive and require significant knowledge of market reaction Being objective is ultimately important

Chapter 8 Quiz 1. Radon gas can indicate the presence of a toxic uranium dump close to the property. can present a problem indoors if allowed to build up to dangerous levels. is a man-made waste byproduct. makes a house worthless because it must be condemned by the EPA.

Chapter 8 Quiz 2. What statement about electromagnetic fields is FALSE? They are created by moving electrical currents. They can affect other charged objects. They can be produced by high-tension power lines. They have been proven to cause cancer.

Chapter 8 Quiz 3. It is well known that a murder took place in a house 40 years ago. This could be an example of an internal obsolescence. neighborhood decline. a stigmatism. social force.

Chapter 8 Quiz 4. A trend of moving to a new suburban area is an example of economic forces locational forces physical forces social forces

Chapter 8 Quiz 5. The state’s housing finance authority has just issued a low-interest, first-time homebuyer mortgage program. Sales are spurred as a result of this governmental force. physical force. social force. supply and demand.

Chapter 8 Quiz 6. Which is an example of the governmental force of revenue generating laws? cost of credit earnings levels permissibility of zoning specific tax policies

Chapter 8 Quiz 7. Wetlands are protected under what federal Act? Clean Water Act Federal Wetlands Protection and Wildlife Act SARA U.S. Army Corps Act

Chapter 8 Quiz 8. Sick building syndrome is a result of a former traumatic act. inadequate soil composition. linkages to toxic waste dumps. poor air quality.

Chapter 8 Quiz 9. The Comprehensive Environmental Response, Compensation, and Liability Act primarily addresses abandoned waste sites. air quality in public buildings. properties ridden with mold. safe drinking water.

Chapter 8 Quiz 10. Which is an example of linkages? estimated driving time from populated areas to major interstate highways known relationship of environmental concerns and terminal illness proximity of hazardous substances to populated areas relationship of household members when analyzing social forces

Chapter 9 Economic Principles and Applications

Chapter 9: Objectives After completing this chapter, students will be able to: Apply economic principles when forming value opinions

Key Terms Amenity Anticipation Balance Buyer’s Market Change Competition Conformity Contribution Excess Land Four Agents of Production Highest and Best Use Interim Use Law of Diminishing Returns Law of Increasing Returns Market Equilibrium Amenity A tangible or intangible feature that enhances and adds value to real estate. Anticipation An economic principle that implies value is created by the expectation of future benefits. Balance 1. A condition that exists in the real estate market when there are slightly more homes available than buyers. 2. The right mix of capital, entrepreneurship/management, labor, and land (the four agents of production) that results in best return on investment from land. Highest and best use occurs when the four agents of production are in balance. Buyer’s Market A situation in the real estate market where buyers have a large selection of properties from which to choose. When there are more properties available than there are buyers in the market. Prices decrease in a buyer’s market. Change A principle affecting value in real estate that says all factors that influence real estate—physical, economic, governmental, and social—are constantly changing, and thus property value itself is subject to constant change. Competition In a free marketplace, this principal states that if excess profits are being generated by a particular product or service, then additional competition will develop. Conformity The principle reflects both the physical compatibility of a property and the economic state of the property. Internal conformity is a state of four agents of production in relation to land use and improvements. External conformity is determined by how a property and its characteristics conform to the market and the demands of market participants. Contribution Economic principle which expresses that value is measured by the benefit of a property element to the whole property, or by how much value would be decreased if that element were not in place. Excess Land Land area that is not necessary to support the use of the existing improvements situated on the subject property. However, it may have its own highest and best use for expansion of the current improvement or for sale for another use. Four Agents of Production The four agents of production are capital, entrepreneurship, land, and labor which together create value in real estate. The four agents of production can be remembered by the acronym C-E-L-L. Highest and Best Use The most reasonably probable legal use of a property, as vacant land or as improved, that is physically possible, adequately supported, financially feasible and results in the greatest value. Interim Use Temporary use of a property while it awaits conversion to its highest and best use (e.g., waiting for a zoning change, accumulation of investment dollars, etc.) Law of Diminishing Returns Economic principle that says that beyond a certain point, the added value of an additional feature, addition, repair, etc., is less than the actual cost of the item. Also called the law of decreasing returns. Law of Increasing Returns Economic principle that says the added value of an additional feature, addition, repair, etc., is more than the actual cost of the item. Market Equilibrium The point of balance where supply and demand meets. Movement toward market equilibrium is a natural tendency and is where price, cost, and value are equal. This seldom occurs.

Key Terms cont. Market-Use Property Single-Use Property Opportunity Cost Principle of Consistent Use Progression Regression Seller’s Market Single-Use Property Special-Use Property Substitution Supply and Demand Surplus Land Surplus Productivity Multiple-Use Property A property that has a limited number of unique uses that may or may not be simultaneous or require little modification to the property. Opportunity Cost The cost that occurs because one action is chosen over another. Principle of Consistent Use Economic principle that holds that when an interim highest and best use is determined, land cannot be valued for one use, while the improvements are valued at another use. Progression When the value of inferior properties is affected positively by other properties around it. Regression When value of a particular property is affected negatively due to being affiliated with inferior properties. Seller’s Market When there are more buyers in the market than there are properties available. Prices rise in a seller’s market. Single-Use Property A property specifically designed and/or built for the user, or one with a unique use that would likely not satisfy other users. Special-Use Property A property that has only a limited and specific use; the value of special-use properties may be difficult to determine because of their limited market. Special-use properties may also be referred to as special-purpose properties. Substitution A principle that says an informed buyer will not pay more for a property, or a feature in a property than a comparable substitute. Supply and Demand A principle of economics that says, for all products, goods, and services, when supply exceeds demand, prices will fall and when demand exceeds supply, prices will rise. Surplus Land The portion over and above what is necessary for the highest and best use of the subject property, and the portion does not have a stand-alone highest and best use. Surplus land is not needed to expand the subject improvements or that of an adjoining property. Surplus Productivity The net income that remains after the costs of various agents of production have been satisfied.

Four Agents of Production C E L L Capital Entrepreneurship Land Labor

Fundamental Economic Principles Anticipation Change Supply and demand Substitution Competition Balance Contribution Conformity Externalities Anticipation is the expectation of future benefits. Change is brought about by variables of the four forces influencing value, physical forces, economic force, governmental forces, and social forces (P-E-G-S). The economic principle of supply and demand implies that for all products, goods, and services, when supply exceeds demand, prices will fall and when demand exceeds supply, prices rise. Substitution is an economic principle which holds that an informed and rational buyer will not pay more for a property than a comparable substitute would cost, or for which a comparable property could be acquired. The economic principle of competition reflects the interaction of supply and demand. In the context of demand, the competition can exist between two or more buyers, two or more sellers, two or more landlords, or two or more tenants. Regarding supply, competition is a level of amenities and benefits of one property over other available properties. Balance is the appropriate mix of the four agents of production—capital, entrepreneurship/management, land, and labor which results in the optimal productivity of a property. When the four agents of production are in optimal balance, the property has achieved its highest and best use. Contribution is based on the preceding economic principle of balance. The economic principle of contribution plays a significant role in interpreting market reaction as the principle implies that cost does not necessarily equal value. An appraiser measures value by the benefit of a property element to the whole property, or by how much value would be decreased if that element were not in place. The economic principle of conformity has a relationship with the principle of balance and the principle of contribution. The principle reflects both the physical compatibility of a property and the economic state of the property. Internal conformity is a state of four agents of production in relation to land use and improvements. This concept is a reflection of the economic principle of balance, which is the optimal harmony among the agents leading to the land and improvements being in a state of highest and best use. External conformity is determined by how a property and its characteristics conform to the market and the demands of market participants, which is the compatibility of the property and whether the improvements are contributing in the most productive manner. The economic principle of externalities focuses on the some of the forces influencing value that were discussed in Chapter 8. This principle recognizes that real estate is different from other products in that it is inherently immobile.

Economic Principles Exercises 1. Value constantly fluctuates due to the principle of _______. 2. When demand exceeds supply, prices will _____. 3. Property uses that compliment each other are evidence of the theory of __________. 4. Value is created through the expectation of future benefits according to the theory of ____________. change rise conformity anticipation

Economic Principles Exercises True or False 5. To an investor, the greater the expectation of benefits from a property, the less valuable it is to the investor. 6. Surplus productivity is realized after various agents of productivity have been satisfied. FALSE TRUE

Economic Principles Exercises 7. Contribution, whether more or less than cost, is measured by the law of __________ and ____________ returns. 8. Name the four agents of production (hint: C-E-L-L): a. Capital b. Entrepreneurship c. Land d. Labor increasing decreasing

Highest and Best Use There is only one highest and best use for land at a given point in time. Land not devoted to highest and best use results in a loss of income. Highest and best use gives the owner maximum economic advantage. The most reasonably probable legal use of a property, as vacant land or as improved, that is physically possible, adequately supported, financially feasible, and results in the greatest value

Highest and Best Use cont. Highest and best use allocates land resources efficiently; maximizing economic return. Highest and best use gives economic benefits to surrounding land (conformity). Highest and best use gives economic benefits to the community (conserves a scarce resource—land).

Four Tests of Highest and Best Use Is the ideal use legally permitted? Is it physically possible for the ideal structure to be built on the property? Is the ideal use economically (financially) feasible on the property? Is the ideal use the maximally productive use for the property?

Value of a Vacant Site or As If the Land Were Vacant

Value of the Land as Improved

Application Illustration 1 A corner lot with commercial zoning currently is improved with a residential dwelling. Determine the appropriate highest and best use recommendation if demand for the commercial site is recognized immediately. Improved value—$185,000 As vacant—$205,000 Demolition cost—$12,000 Recommendation: Raise the dwelling to make the site vacant. $205,000 – $12,000 (demolition cost) = $193,000 $193,000 – $185,000 = $8,000 higher value

Application Illustration 2 A single-family residence is currently valued at $58,000. The majority of properties within close proximity to the subject are duplexes with typical values in the range of $79,000. If the cost of converting the subject’s single-family residence into a duplex has been estimated at $20,000, and the interior demolition is estimated to be $1,000, what is the highest and best use conclusion? Conclusion: The highest and best use of the property remains as a single-family residence, since there is no entrepreneurial reward for the owner upon completion of the conversion. $58,000 + $20,000 + $1,000 = $79,000

Application Illustration 3 A real property appraiser is performing a highest and best use analysis for a vacant parcel. The appraiser has determined that the highest and best use of the parcel is for a two to four unit apartment building with (per maximum lot coverage) exterior dimensions of 4,000. Which improvement should the appraiser suggest? • Two, four-bedroom, three-bath units which could each rent for $1,250 per month. Indicated value by the income approach is $42.50 per square foot and cost of the 4,000 square foot building will be $67.00 per square foot. • Three, three-bedroom, two-bath units which could each rent for $950 per month. Indicated value by the income approach is $50.59 per square foot and cost of the 4,000 square foot building will be $49.00 per square foot. • Four, two-bedroom, two-bath units which could each rent for $750 per month. Indicated value by the income approach is $44.25 per square foot and cost of the 4,000 square foot building will be $45 per square foot.

Application Illustration 3 continued Suggested unit type and mix: Three three-bedroom, two-bath units Two, four-bedroom, three-bath units 4,000 × $42.50 = $170,000 4,000 × $67.00 = $268,000 Three, three-bedroom, two-bath units 4,000 × $50.59 = $202,360 4,000 × $49.00 = $196,000 Four, two-bedroom, two-bath units 4,000 × $44.25 = $177,000 4,000 × $45.00 = $180,000

Application Illustration 4 A 20,000 square foot residential lot zoned for single-family or two-family use is the subject of an appraisal assignment. The lot is currently improved with a 1,800 square foot single-family residence. What is the indicated highest and best use? • Vacant land value—$0.75 per square foot • Razing cost—$8,000 • Present value of single-family dwelling from paired data—$80 per square foot. • Potential monthly rent if converted to two-family—$800 each • Indicated value by the income approach per square foot—$96 • Conversion cost to two-family—$28,000

Application Illustration 4 continued Indicated highest and best use: Converted to two-units Vacant: 20,000 square feet × $0.75 per square foot = $15,000 Razing cost: $8,000 $15,000 – $8,000 = $7,000 “As is”: 1,800 square feet × $80 = $144,000 Converted: 1,800 square feet × $96 = $172,800 – $28,000 conversion = $144,800

Application Illustration 5 A single-family dwelling contains 1,860 square feet and is situated on a commercially zoned lot that is 155’ x 220’. If, through paired-data, the improved property has a per square foot value of $58 and the commercial land value in this area is $150,000 per acre, what is the highest and best use if the razing cost is estimated to be $20,000? Highest and best use conclusion: as-improved As-improved: 1,860 × $58 = $107,880 Vacant: 155 × 220 = 34,100 ÷ 43,560 = 0.7828 acre 0.7828 × $150,000 = $117,424 – $20,000 = $97,424

Interim Use A temporary use of property while it awaits conversion to its highest and best use E.g., waiting for a zoning change or accumulation of investment dollars Appraiser must observe the principle of consistent use: Land cannot be valued for one use while the improvements are valued for another use

Final Determination of Highest and Best Use

Special Uses Single-use property Multiple-use property Special-use property Single-Use Property A single-use property is one specifically designed and/or built for the user, or one with a unique use that would likely not satisfy other users. The value for a single-use property is generally its value in use. Multiple-Use Property A multiple-use property has a limited number of unique uses that may or may not be simultaneous or require little modification to the property. The value for a multiple-use property is often its value in use. This may or may not equal market value. Special-Use Property A special-use property has only a limited and specific use. The value of special-use properties may be difficult to determine because of their limited market. Special-use properties may also be referred to as special-purpose properties. Some examples include museums, historical buildings, and schools.

Surplus and Excess Land Surplus land Portion over and above what is necessary for the highest and best use of the subject property and does not have a stand-alone highest and best use Excess land Land (or site) area that is not necessary to support the use of the existing improvements situated on the subject property

Highest and Best Use Application Exercise 1. For an improved property, highest and best use analyzes whether the current improvements should be 2. Zoning is one consideration of 3. Highest and best use gives the property owner maximum 4. As a(n) use, the property could be held for future development. 5. The four tests of highest and best use are: 1. Legally permissible 2. Physically possible 3. Financially feasible 4. Maximally productive razed, converted, or left “as is.” legally permissible. economic advantage. interim

Case Study 9.1 Corner Commercial Site with Use and Non-Compete Restrictions

Case Study 9.1 Certified general appraiser, Max Riley, was performing a highest and best use analysis of a high-visibility corner commercial site that is located on Hightown’s primary commercial strip. Three major shopping malls and strip centers are across the street from the subject. Another is located adjacent to it on the same side of the street. The subject parcel contains approximately one acre and is improved with a 1960’s automotive service station that has not operated for a number of years. The site has been rented throughout recent years to various vendors selling flowers, fruits and vegetables, and other seasonal products. The fuel storage tanks have been removed from the site and the property has been certified to be environmentally sound. The property owner, a private individual, realizes the property is too valuable to continue its present use and has asked appraiser Riley to determine its value for marketing purposes. Appraiser Riley surveys the area and the market and has found no other sites immediately available in this highly desirable area. His research has revealed that the last similar comparable one-acre parcel sold approximately two years ago for $850,000. The comparable parcel—an interior lot without the corner influence—was located approximately 1,000 feet from the subject. On inquiry with the broker facilitating that transaction, he found the comparable property went under contract to a restaurant enterprise, soon after being offered to the market. The broker also noted that he received two additional backup offers for the property. One was for $850,000, and the other was for $900,000. Both of these offers were from similar restaurant developers.

Case Study 9.1 Demand Utility Scarcity cont. Point Break Of the characteristics effecting value, which characteristics have been identified? Demand Utility Scarcity

Case Study 9.1 cont. Further information obtained from the real estate broker indicated that all offers for the comparable parcel were from restaurants that required a site for which a liquor license could be obtained. The broker also had interest from other non-liquor food service users including fast-food facilities. But, none of these non-liquor vendors would be willing to pay as much as those requiring a liquor license. Appraiser Riley’s research confirms this trend with non-liquor restaurants paying up to 50% less than those requiring a liquor license. Additionally, appraiser Riley confirms with the state liquor control board that a liquor license would be available for the site.

Case Study 9.1 Restaurant desiring to sell alcohol cont. Point Break From this information, what conclusion could be drawn about the highest and best use of the subject property? Restaurant desiring to sell alcohol

Case Study 9.1 cont. After performing a highest and best use analysis of the property, appraiser Riley has determined that a restaurant use that requires a liquor license would be the highest and best use of the property. The use as a site for a non-alcohol restaurant was analyzed; after considering they typically pay substantially less for a commercial site that option was eliminated. Alternative users, such as most retail, typically pay up to 50% less than a non-alcohol product restaurant. After considering supply and demand patterns, historic sales data, and the physical characteristics of the subject parcel, the appraiser’s value opinion is a range of $1,200,000 to $1,500,000. Appraiser Riley holds a meeting with the property owner. After a presentation of the marketability and value opinion of the property, the property owner offers that there may be a problem. The property owner inherited the property from his mother, a conservative lady who was strongly opposed to alcohol. He believes there may be some restriction relating to alcohol and the use of the property. Following up on this information, appraiser Riley finds a deed restriction stating “the property may never be used for the sale or consumption of alcohol.”

Case Study 9.1 cont. Point Break How does this deed restriction impact the use and value of the property? The number of interested users has been affected by the restriction. Based on the data given, the property's value diminishes by at least 50%.

Case Study 9.1 cont. Point Break Are there potential remedies or alternatives? Since the owner inherited the property and the restriction, he might be able to file for a court action to have the restriction removed

Case Study 9.1 cont. Appraiser Riley suggests that the property owner seek legal counsel to discuss the restriction and any potential solutions. Legal counsel suggests that, in this particular case, a court action could be filed to seek removal of the restriction claiming it is unreasonable and has a significant and unreasonable impact on the property value as alternative highest and best uses could result in up to a 50% downward impact on it. After deep consideration, the property owner was not willing to challenge his mother’s request.

Case Study 9.1 cont. Point Break How does this information affect the highest and best use? Changes the highest and best use to an establishment that does not sell liquor, such as fast food

Case Study 9.1 cont. With this decision, the appraiser now deems the highest and best use to be as a food service facility that does not sell liquor. At this point, the property owner tells appraiser Riley that he also owns the land and building immediately next door to the subject. It was built for and leased to a fast-food facility specializing in roast beef sandwiches about 25 years ago. He also inherited this property. The restaurant has been a good tenant and is currently engaged in a lease with 10 years remaining. Appraiser Riley asks to review the fast-food restaurant’s lease.

Case Study 9.1 A non-compete agreement cont. Point Break What type of information is appraiser Riley looking for? A non-compete agreement

Case Study 9.1 cont. In the course of reviewing the lease, appraiser Riley finds what he suspected—the non-compete agreement. The agreement states that “during the term of this lease, no property owned by the lessor, within a three mile radius, shall be sold or leased for the sale or consumption of roast beef, hamburgers, chicken, and fish.”

Case Study 9.1 Eliminates most fast food users cont. Point Break How has the information impacted highest and best use and the value of the property? What vital characteristic of value is at issue, or not present? Eliminates most fast food users As the uses of a property diminish, so does the property’s value The property was sold to chain of doughnut shops. They paid $375,000 for the site.

Chapter 9 Quiz 1. Highest and best use allocates land resources efficiently. always considers the intended use of the owner. can be several different uses at any given time. results in a minimal loss of income.

Chapter 9 Quiz 2. Externalities can be a positive or negative influence on value, primarily due to the property characteristic of balance. immobility. level benefits. surplus productivity.

Chapter 9 Quiz 3. An interim use might be determined when the appraiser is unable to make a determination due to limited data. the owner cannot make up his mind on what to do. a reasonable and probable change in circumstances is forthcoming. waiting for a volatile market to settle before deciding.

Chapter 9 Quiz 4. Regarding “physically possible,” which would NOT be considered? building materials building set back lines parking requirements size of the building

Chapter 9 Quiz 5. A school building might be an example of a(n) __________ property. commercial-use multiple-use special-use utility-use

Chapter 9 Quiz 6. When the highest and best use of the property is “vacant,” the current improvements are in a state of equilibrium. lending no value to the vacant site. taking away from the value of the vacant site. taking away from the vacant site value by more than the cost to raze the improvements.

Chapter 9 Quiz 7. When a buyer will not pay more for something than its cost, the buyer is influenced by contribution. opportunity cost. substitution. supply and demand.

Chapter 9 Quiz 8. Which is NOT one of the four agents of production? capital gross profit labor land

Chapter 9 Quiz 9. The law of diminishing returns is most directly linked to which economic principle? change competition contribution substitution

Chapter 9 Quiz 10. When properties are listed at a certain price in the neighborhood, that price tends to set the limits of value for other properties around it, according to the concept of balance. competition. contribution. Substitution.

Chapter 9 Quiz 11. Which economic principle suggests that value is created through expectation of future benefits? anticipation balance contribution surplus productivity

Chapter 9 Quiz 12. Which of the following is likely to contribute the most value? adding 500 square feet to a 1,200 square feet house, where 1,200 square feet is the predominant square footage adding a fence where fences are prohibited adding a second bath to a three-bedroom house, where three bedrooms, two baths is the norm changing granite countertops to laminate

Chapter 9 Quiz 13. The largest and most expensive house in the neighborhood could likely be experiencing regression through which economic principle? anticipation conformity substitution surplus productivity

Chapter 9 Quiz 14. When might a residual physical segment of a land parcel be considered surplus site? if it is needed for future expansion of the subject’s improvements if it would be legally permissible to have another house built on it when it cannot be legally sold separately from the subject property when it could freely transfer and be made available to the open market

Chapter 9 Quiz 15. Which is included within the test of “legally permissible”? allowable to zoning hazard insurance could be obtained police protection is available title is free of encumbrances

Chapter 10 Overview of Market Fundamentals

Chapter 10: Objectives After completing this chapter, students will be able to: Identify supply and demand model as part governmental and part economic Describe the role of money and capital markets

Key Terms Adjustable Rate Mortgages (ARMs) Debt Deficit Spending Amortization Amortized Loans Balloon Mortgage Command Economic System Conforming Loan Conventional Loan Debt Deficit Spending Discount Rates Economics Equity Federal Budget Deficit Fed Funds Rate Adjustable Rate Mortgages (ARMs) A mortgage that permits the lender to periodically adjust the interest rate to reflect fluctuations in the cost of money. Amortization When the principle and interest of a loan is repaid in installments. During the amortization process the debt is retired along with all interest on the principle balance. Amortized Loans Loans in which payments are applied to principal and interest. A loan that is fully amortized means that the total payments over the life of the loan will pay off the entire balance of principal and interest due at the end of the term. Balloon Mortgage A mortgage which is not fully amortized and becomes due and payable in a lump sum (balloon balance). Command Economic System One where the government, or other central authority, makes all decisions about production and distribution. Conforming Loan A loan that meets the qualifying standards and can be sold on the secondary market. Conventional Loan A loan not insured or guaranteed by a government entity. Debt The portion of an investment that is borrowed from another source. Deficit Spending When the government spends more money than it takes in from tax revenue. Discount Rates The interest rate charged by Federal Reserve Banks on loans to member commercial banks. Also referred to as the federal discount rate. Economics The study of how resources are allocated. Equity The funds (cash) the investor puts into an investment, For real estate investments this is the monetary difference between potential selling price and any amount owed on the property. Federal Budget Deficit When federal government income is less than its expenditures. Fed Funds Rate The Federal Reserve’s target for short-term interest rates. Federal Home Loan Mortgage Corporation (Freddie Mac) Nonprofit, federally chartered institution (now privately owned) that functions as buyer and seller of residential mortgages.

Key Terms cont. Federal Reserve Board Fiscal Policy Federal Home Loan Mortgage Corporation (Freddie Mac) Federal National Mortgage Association (Fannie Mae) Federal Open Market Committee (FOMC) Federal Reserve Banks Federal Reserve Board Fiscal Policy Government Loan Government National Mortgage Association (Ginnie Mae) Inflation Monetary Policy Moral Suasion Federal Home Loan Mortgage Corporation (Freddie Mac) Nonprofit, federally chartered institution (now privately owned) that functions as buyer and seller of residential mortgages. Federal National Mortgage Association (Fannie Mae) The nation’s largest, privately owned, investor in residential mortgages. Federal Open Market Committee (FOMC) A body that controls the Fed’s sale and purchase of government securities. The FOMC consists of the seven members of the Federal Reserve Board, plus the President of the Federal Reserve Bank of New York, and four other Federal Reserve Bank Presidents. Federal Reserve Banks Banks that provide services to financial institutions (e.g., check clearing), which have one main office in each Federal Reserve district. All nationally chartered commercial banks must join the Federal Reserve and buy stock in its district reserve bank. Federal Reserve Board The government body responsible for U.S. monetary policy, maintaining economic stability, and regulating commercial banks. Fiscal Policy The government’s plan for spending, taxation, and debt management. Government Loan One which is insured or guaranteed by the federal government; the federal government insures or guarantees the loan to protect the lender in case of default (e.g., VA and FHA financing are government loans). Government National Mortgage Association (Ginnie Mae) Government-owned corporation that guarantees payment of principal and interest to investors who buy its mortgage backed securities on the secondary market. Inflation When the purchasing power of money is diminished due to prices rising and an increased volume of money. Monetary Policy The government’s means of controlling the supply and cost of money. Moral Suasion Attempt to use persuasive influences on the public and financial markets, so they will perceive credit in a specific way.

Key Terms cont. Mortgage Private Mortgage Insurance (PMI) Mortgagee Mortgagor Nonconforming Loan Open Market Operations Portfolio Lenders Primary Mortgage Markets Private Mortgage Insurance (PMI) Purchase Money Mortgage Reserve Requirements Secondary Mortgage Markets U.S. Treasury Department Mortgage A pledge of real property in which the borrower, called the mortgagor, pledges his or her property to the lender, called the mortgagee, as collateral for the debt. Mortgagee A lender who accepts a mortgage as security for repayment of the loan. Mortgagor A person or entity who borrows money and gives a mortgage to the lender as security. Nonconforming Loan Loans that do not meet qualifying standards of the secondary market. Open Market Operations When the Federal Reserve Board sells or buys government securities (bonds) as a means of controlling the supply of and demand for money. The Fed can also buy and sell U.S. dollars on the international market. Portfolio Lenders Financial institutions that make real estate loans that they keep and service in house instead of selling them on the secondary markets. Primary Mortgage Markets When lenders make mortgage loans directly to borrowers. This is also referred to simply as primary markets. Private Mortgage Insurance (PMI) Insurance offered by private companies to insure a lender against default on a loan by a borrower. Purchase Money Mortgage A mortgage where the seller finances all or part of the sale price of property for a buyer. Reserve Requirements The percentage of customers’ deposits that commercial banks are required to keep on deposit on hand either at the bank or in a bank’s own accounts. Money a bank cannot lend to other people. Secondary Mortgage Markets The private investors and government agencies that buy and sell real estate mortgages. Also called secondary markets. U.S. Treasury Department The part of the executive branch of the federal government that is the fiscal manager of the nation. The U.S. Treasury is responsible for carrying out the nation’s fiscal policy by doing the actual spending, taxing, and debt financing via an account it keeps with the Federal Reserve.

Broad Economic Concepts Economics: The study of how resources are allocated Fiscal policy Monetary policy

Command Economy vs. Market Economy Command economic system Government or other central authority makes all decisions about production and distribution Market economic system Individual people and businesses are free to make their own decisions about production and distribution

Supply-Side vs. Demand-Side Economics Supply-side economics Seeks to create economic activity by having the government lower taxes Allow market forces to determine where the most productive investment and job creation should take place Demand-site economics Seeks to create economic activity through government spending aimed at job creation Keynesian economics

Money Supply Fiscal policy Monetary policy U.S. Treasury Department, IRS Deficit spending, taxation Monetary policy Federal Reserve Board Prices, interest rates, financial markets

Monetary Policy Implementation Four tools used by the FED (D O R M) Discount rates Open market operations Reserve requirements Moral suasion Discount rates or federal discount rates are the interest rates charged by Federal Reserve Banks on loans to member commercial banks. Open market operations are when the Fed sells or buys government securities (bonds) as a means of controlling the supply of and demand for money. Reserve requirements are the percentage of deposits commercial banks are required to keep on deposit, either on hand at the bank or in the bank’s own accounts, in other words, money the bank cannot lend to customers. Moral suasion is using persuasive influences on the public and financial markets, so they perceive credit in a specific way.

Role of Money and Capital Markets Competing investments Debt investors: Conservative and passive; favor bonds and mortgages with a certain return and repayment of principal Equity investors: Aggressive and open to more risk; venture capital Sources of capital Debt and equity Cash, REITs, partnerships, syndications, joint ventures, pension funds, insurance companies

Mortgage Markets Primary mortgage markets Secondary mortgage markets Lenders who make mortgage loans directly to borrowers Portfolio lenders Secondary mortgage markets Private investors and government agencies that buy and sell real estate mortgages

Function of Secondary Mortgage Markets Buy and sell mortgages from primary market lenders The primary lenders (e.g., local banks) then have more money to lend to other potential borrowers Local banks invest surplus funds in real estate investments from other regions—real estate cycles are then moderated by stable investments from areas going through different phases of the cycle Standardization loan criteria

The Agencies of Secondary Mortgage Market Federal National Mortgage Association (Fannie Mae) Government National Mortgage Association (Ginnie Mae) Federal Home Loan Mortgage Corporation (Freddie Mac)

Conforming vs. Nonconforming Loan General terms of the mortgage loan application meet the requirements of the secondary market’s underwriting guidelines or a private investor’s lending policy Considered low risk for the investor Nonconforming loan Have one or more underwriting indicators that fall outside the acceptable range of guidelines Considered higher risk for the originating lender

Underwriting Standards Loan-to-value (LTV) ratios Income-expense ratios In order to sell mortgages on the secondary market, lenders must conform to underwriting guidelines Implements quality control Increases quality of the loans lenders make

Overview of Mortgages First mortgage Second mortgage Amortization A security instrument that has a first mortgage lien position; has priority over all other mortgages Second mortgage A security instrument in second lien position Also called junior mortgages Amortization The principal and interest of a loan is repaid in installments

Types of Mortgages Conventional loans Government loans May have private mortgage insurance (PMI) Government loans FHA loans, VA loans Adjustable rate mortgages (ARMs) Purchase money mortgages Balloon mortgages A conventional loan is any loan not insured or guaranteed by a government agency (such as FHA or VA). A government loan is one which is insured or guaranteed by the federal government. Adjustable Rate Mortgages (ARMs) permit the lender to periodically adjust the interest rate to reflect fluctuations in the cost of money. A purchase money mortgage is given by a buyer to a seller, who is acting as the lender, to secure part or all of the money borrowed to purchase property. This mortgage contains all of the elements and follows all of the rules and procedures for any type of mortgage. A balloon mortgage is one which is not fully amortized and becomes due and payable in a lump sum prior to the full amortization period.

Chapter 10 Quiz 1. The federal government influences the money supply through fiscal and monetary policy. physical and social factors. rules of equilibrium. supply and demand.

Chapter 10 Quiz 2. The Treasury Department is NOT responsible for federal spending. managing the federal deficit. tax collection. secondary mortgage markets.

Chapter 10 Quiz 3. The Federal Reserve System has how many regional Federal Reserve Banks? 6 8 12 14

Chapter 10 Quiz 4. Tools used by the Fed to implement monetary policy include Congressional Acts. discount rates and reserve requirements. fiscal assertiveness. prime rates and subprime rates.

Chapter 10 Quiz 5. The U.S. Treasury is responsible for __________ policy. economic fiscal monetary social

Chapter 10 Quiz 6. The amount a commercial bank must keep on deposit is known as equilibrium. monetary policy. reserve requirements. supply and demand.

Chapter 10 Quiz 7. If the federal government spends less money than revenue, which would likely occur? Interest rates would rise sharply for mortgage loans. Federal Reserve Board would not meet. Market equilibrium would occur in the Federal Reserve. More funds would be available for real estate loans.

Chapter 10 Quiz 8. Tax credits, such as those created through the American Recovery and Reinvestment Act of 2009, are an example of which force influencing the value of real property? economic governmental physical social

Chapter 10 Quiz 9. Which is NOT a source of equity used as capital for acquisition of investment real estate? joint ventures mortgages partnerships pensions funds

Chapter 10 Quiz 10. What is the lump-sum remaining principle balance referred to that is payable when a mortgage loan is not fully amortized? balloon balance deficit balance discount balance passive balance

Chapter 10 Quiz 11. In general, conforming conventional mortgage loans represent less risk of loss to the lender. a loan avenue for borrowers who have a high debt to income ratio. loans that are insured or guaranteed by the government. an opportunity to charge a higher interest rate.

Chapter 10 Quiz 12. Which is an advantage of the secondary mortgage market? Lenders can sell existing lower interest rate loans to free-up money. The lender is only lending funds from their institutions deposits. Secondary market loans are only for home equity loans, so there is less risk. There are no national requirements for the secondary market.